This is the first article in a series of three articles focused on pressing issues that hospital and health system executives need to consider when exploring and beginning mergers and acquisitions.

When leaders of hospitals and/or health systems know they would like to explore transaction deals, a key step is identifying a partner. However, before organizations reach that step, they need to address three key areas of the transaction process: strategic, clinical and operational.

According to Chip Hurley, CPA, leader of the healthcare financial advisory services practice for Berkeley Research Group — a global consulting firm with a focus in healthcare — the strategy behind a transaction dictates the characteristics needed in a potential partner. For this reason, it is a crucial piece to the transaction process. Here, he and Andrew Agwunobi, MD, leader of the hospital performance improvement practice for BRG, discuss eight strategies behind hospital transactions they find to be most common and influential.

8 strategies for hospital transactions

1. Survival. One of the most common strategies is the survival strategy, which is used to help financially dissolute hospitals to survive. "They need a transaction to ensure the hospital will operate in the future," says Mr. Hurley. 

2. Profit enhancement. With the profit enhancement strategy, a hospital may not be struggling financially, but it is hoping to forego financial dissolution down the road. For this reason, profit enhancement strategy is different from survival strategy. "[The hospital is] not struggling financially, but it may have lower profit margins than previously. It may have tried to improve profits as a standalone hospital, but now it needs extra help," says Mr. Hurley.

3. Market position/competition. According to Mr. Hurley, hospitals often merge to enhance overall market position, either because they want a higher bond rating, are in an urban area with high hospital concentration or have a small geography and want to enhance that. The strategy for a bigger footprint is closely tied with competition.
"A lot of urban settings are becoming more competitive — competing for managed care contracts and patient volume. A lot of times smaller organizations do not feel they can compete, so they are joining larger partners in their market place," says Dr. Agwunobi.

4. Mission. Hospitals merge or partner to preserve their missions. "Many Catholic hospitals have struggled, for example, and they merge with other organizations — sometimes with a Catholic or a non-religious hospital — to preserve their mission," says Mr. Hurley. "It does not always mean a religious mission. Sometimes there are other missions hospitals want to preserve."

For instance, hospitals have missions for charity care, indigent care and service commitments to the community. "A hospital's board should always be thinking about what is good for the community — giving the community better access, better affordability and better quality of care," says Mr. Hurley.

5. Investment. Another major strategic reason hospitals pursue transactions is to invest in healthcare — in a certain geography or a certain type of hospital — in order to improve EBITDA operating results. Such a transaction may also grow the top line revenues such that the investor can someday sell the investment for a higher multiple of EBITDA making a significant profit. "I see this especially in the for-profit arena when the deals are backed by venture capitalists," says Mr. Hurley.

6. Defense. The defense strategy often involves smaller hospitals preparing for changes in their market, such as other hospitals consolidating or a larger system coming into the area. "I have seen transactions develop because a hospital in a smaller town with little competition sees mergers occurring and it does not want to be left without the strength of a partner. So, it is interested in a transaction from a defensive standpoint," says Mr. Hurley.

Dr. Agwunobi agrees, adding: "I have seen situations where organizations have felt that by coming together they can prevent outside larger chains from coming into their service area."

7. Healthcare reform/population health management. Many hospitals began looking at merger opportunities as a result of healthcare reform. Healthcare reform brought the concept of accountable care organizations and population health management to a broader spotlight. According to Mr. Hurley, ACOs are not always cost-effective for smaller hospitals — they either do not know how to start one or they are not big enough to take on the additional cost and risk. So, they look to merger opportunities as a means for meeting those new initiatives.

8. Leadership. According to Dr. Agwunobi, sometimes hospitals come together with others to access leadership talent. "If one hospital or health system is extremely well led by a high-caliber management team, and there is turnover in management at another hospital in the same market space, the first hospital's board may think about a merger to access needed talent," says Dr. Agwunobi.
Implications for the partnership search
As mentioned earlier, the strategic reason a hospital or health system explores a transaction often has implications for the partnership process. The type of partner that is considered will change depending on the strategy — a hospital will look for different assets, benefits and characteristics, says Mr. Hurley.

Here are two distinct examples of how strategy changes the partnership search and decision process:

If the strategy is survival or profit enhancement…
According to Mr. Hurley, if a hospital's strategy involves survival or profit enhancement, it will look for a partner that can ensure these two elements moving forward. "The hospital will look for a financially sound partner with lots of cash on hand as well as a proven track record of financial performance and operational efficiency," he says.

If the strategy is population health management…
When a hospital considers a transaction for population health management, it will look for a partner that has experience, breadth and clout — or at least a solid plan — for population health management and/or forming ACOs, says Mr. Hurley. One caveat is that at this stage in the game, there are not a great number of hospitals or health systems with solid, successful experience in ACOs.

"If a hospital limits the partnership search to ACO experience, it may not find a partner. It has to dive in to the management styles and cultures of the organizations to figure out which organizations are moving forward and which organizations are in a 'wait and see' mode," says Mr. Hurley. "A small hospital that is considering merging needs a partner aimed at the wave of the future, not a partner that is sitting around."

The strategy behind transactions is a key component of the process for exploring, negotiating and finalizing a deal. The eight strategic reasons listed above may influence the partnership search and decision process. For this reason, the strategy should be clearly understood and defined by all hospital and/or health system leaders.

To read the second article on clinical considerations for a hospital transaction, click here.

More Articles on Hospital Transaction Strategy:

Hoag CEO Dr. Richard Afable, St. Joseph Health CFO Darrin Montalvo Discuss the Strategy Behind Their Affiliation
4 Points for Managing an Efficient, Defensible Transaction
3 Successful Strategies to Deal With Potential M&A Landmines